Forecasting

© 2008 Prentice Hall, Inc. 4–1

 What is Forecasting?
 Process of
predicting a future
event
 Underlying basis of
??
all business
decisions
 New Facility
Location
 Inventory
 Personnel
 Capital Investment
© 2008 Prentice Hall, Inc. 4–2
 • Is the forecasting different for goods
and services?

© 2008 Prentice Hall, Inc. 4–3

 Forecasting in the Service
Sector
 Presents unusual challenges
 Special need for short term records
 Needs differ greatly as function of
industry and product
 Holidays and other calendar events
 Unusual events

© 2008 Prentice Hall, Inc. 4–4

 Fast Food Restaurant
Forecast
20% –
Percentage of sales

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12
© 2008 Prentice Hall, Inc. 4–5
 FedEx Call Center Forecast
12% –

10% –

8% –

6% –

4% –

2% –

0% –
2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day
Figure 4.12
© 2008 Prentice Hall, Inc. 4–6
 Seven Steps in Forecasting
 Select the items to be forecasted
 Determine the time horizon of the
forecast
 Select the forecasting model(s)
 Gather the data
 Make the forecast
 Validate and implement results

© 2008 Prentice Hall, Inc. 4–7

 Forecasting Approaches
Qualitative Methods
 Used when situation is vague
and little data exist
 New products or services
 New technology
 Involves intuition, experience

© 2008 Prentice Hall, Inc. 4–8

 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products or services
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of tickets in
picture hall

© 2008 Prentice Hall, Inc. 4–9

 Overview of Qualitative
Methods
 Jury of executive opinion
 Pool opinions of high-level experts,
sometimes augment by statistical
models
 Delphi method
 Panel of experts, queried iteratively

© 2008 Prentice Hall, Inc. 4 – 10

 Overview of Qualitative
Methods
 Grass Root Method
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
 Consumer Market Survey
 Ask the customer

© 2008 Prentice Hall, Inc. 4 – 11

 Jury of Executive Opinion
 Involves small group of high-level experts
and managers
 Group estimates demand by working
together
 Combines managerial experience with
statistical models
 Relatively quick
 ‘Group-think’
disadvantage

© 2008 Prentice Hall, Inc. 4 – 12

 Grass Root Method
 Each salesperson projects his or
her sales
 Combined at district and national
levels
 Sales reps know customers’ wants
 Tends to be overly optimistic

© 2008 Prentice Hall, Inc. 4 – 13

 Delphi Method
 Iterative group Decision Makers
(Evaluate
process, responses and
continues until make decisions)
consensus is
reached Staff
(Administering
 3 types of survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
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 Consumer Market Survey

 Ask customers about purchasing

plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

© 2008 Prentice Hall, Inc. 4 – 15

 Overview of Quantitative
Approaches
1. Naive approach Time-
2. Moving averages Series
Models

Associative
3. Linear regression or Causal
Model

Assumption:
Data follow an identifiable pattern over the time
© 2008 Prentice Hall, Inc. 4 – 16
 Time Series Forecasting
 Set of evenly spaced numerical data
 Obtained by observing response
variable at regular time periods
 Forecast based only on past values,
no other variables important
 Assumes that factors influencing
past and present will continue
influence in future

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 Time Series Components

Trend Cyclical

Seasonal Random

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 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual
demand

Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
© 2008 Prentice Hall, Inc. 4 – 19
 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration
For example, population
increases over a period of time,
price increases over a period .
Usage of bulock carts
decreases
© 2008 Prentice Hall, Inc. 4 – 20
 Seasonal Component
 Regular pattern of up and
down fluctuations in a year
and occur every year
 Due to weather, customs, etc.
 Occurs within a single year
The sales in the departmental stores are more during festive
seasons that in the normal days.
Hotels Seasons

© 2008 Prentice Hall, Inc. 4 – 21

 Cyclical Component
 Repeating up and down movements
 Affected by business cycle, political,
and economic factors
 Multiple years duration

prosperity,
recession,depression and
recovery

0 5 10 15 20
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 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or
unforeseen events
 Short duration and
nonrepeating
Irregular fluctuations results due
to the occurrence of unforeseen
events like
floods,earthquakes,wars,famines,
etc. M T W T F
© 2008 Prentice Hall, Inc. 4 – 23
 Naive Approach

 Assumes demand in next

period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point

© 2008 Prentice Hall, Inc. 4 – 24

 Moving Average Method
 MA is a series of arithmetic means
 Used if little or no trend
 Used often for smoothing

∑ demand in previous n periods

Moving average = n

© 2008 Prentice Hall, Inc. 4 – 25

 100 Room hotel Occupancy
 Manager is concerned about only
Saturday’s demand forecast
 Saturday’s =Guests for vacations
 Noted that for last two Sat demand
is quite high
 Doesn’t want to offer discounts

© 2008 Prentice Hall, Inc. 4 – 26

 Moving Average Example
Saturday Occupancy at a 100-room Hotel

Three-period
Saturday Period Occupancy Moving Average Forecast

Aug. 1 1 79
8 2 84
15 3 83 82
22 4 81 83 82
29 5 98 87 83
Sept. 5 6 100 93 87
12 7 93

© 2008 Prentice Hall, Inc. 4 – 27

 Theme Park has the sales data of tickets for
2013.Forecast sales of 2014 months April to
August

Actual 3-Month
Month Ticket Sales(00’) Moving Average(2014)
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

© 2008 Prentice Hall, Inc. 4 – 28

 Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
22 –
Sales

20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

© 2008 Prentice Hall, Inc. 4 – 29

 Weighted Moving Average

 Used when trend is present

 Older data usually less important
 Weights based on experience and
intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average = ∑ weights

© 2008 Prentice Hall, Inc. 4 – 30

 Weights Applied Period
Weighted Moving Average
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Tickets Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

© 2008 Prentice Hall, Inc. 4 – 31

 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2

© 2008 Prentice Hall, Inc. 4 – 32

 Exponential Smoothing
Model
Ft = Ft-1 + a(At-1 - Ft-1)
a = smoothing constant

• Premise: The most recent observations

might have the highest predictive value.
• Therefore, we should give more weight to
the more recent time periods when
forecasting.
© 2008 Prentice Hall, Inc. 4 – 33
 Exponential Smoothing
Model
Ft = Ft-1 + a(At-1 - Ft-1)
a = smoothing constant/ response
rate
• Ft – The exponential smoothed forecast
for period t
• Ft-1 – Forecast made for the prior period
• At-I – The actual demand in the prior
period
© 2008 Prentice Hall, Inc. 4 – 34
 How to predict alpha (0-1)
• Depends on nature of demand of
product
– When the demand is stable like of food
or electricity-small alpha
– When the demand is rapidly increasing
or decreasing like of fashion items, new
appliances and gadgets- large alpha

© 2008 Prentice Hall, Inc. 4 – 35

 Exponential Smoothing
Problem (1) Data
Week Demand • Question: Given the
1 820 weekly demand data of
2 775 apparels in West Side,
3 680 what are the
4 655 exponential smoothing
5 750 forecasts for periods 2-
6 802
10 using a=0.10 and
7
8
798
689
a=0.60?
9 775 • Assume F1=D1
10

© 2008 Prentice Hall, Inc. 4 – 36

 Answer: The respective alphas columns denote the forecast
values. Note that you can only forecast one time period into
the future.
Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.48
8 689 786.64 787.50
9 775 776.88 727.80
10 776.69 756.00
© 2008 Prentice Hall, Inc. 4 – 37
 Exponential Smoothing
Problem (1) Plotting
Note how that the smaller alpha the smoother
the line in this example.

850
800
d 750 Demand
n 700
a 0.1
m 650
e 600 0.6
D
550
500
1 2 3 4 5 6 7 8 9 10
Week

© 2008 Prentice Hall, Inc. 4 – 38

 Exponential Smoothing
Problem (2) Data
Question: What are the
Week Demand
exponential smoothing
1 820
forecasts for periods 2-
2 775 5 using a =0.5?
3 680
4 655
5 Assume F1=D1

© 2008 Prentice Hall, Inc. 4 – 39

 Exponential Smoothing
Problem (2) Solution
F2=820+(0.5)(820-820)=820 F3=820+(0.5)(775-
Ft = Ft-1 + a(At-1 - Ft-1) 820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
© 2008 Prentice Hall, Inc. 4 – 40
 The MAD Statistic to Determine
Forecasting Error
n
1 MAD  0.8 standard deviation
A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n
• The ideal MAD is zero. That would mean
there is no forecasting error.

• The larger the MAD, the less the desirable

the resulting model.

© 2008 Prentice Hall, Inc. 4 – 41

 MAD Problem Data
Question: What is the MAD value
given the forecast values in the table
below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
© 2008 Prentice Hall, Inc. 4 – 42
 MAD Problem Solution
Month Sales Forecast Abs Error
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

n
Note that by itself, the MAD
A
t=1
t - Ft
40 only lets us know the mean
MAD = = = 10 error in a set of forecasts.
n 4

© 2008 Prentice Hall, Inc. 4 – 43

 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

© 2008 Prentice Hall, Inc. 4 – 44

 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
© 2008 Prentice Hall, Inc. 4 – 45
 Values of Dependent Variable
Least Squares Method

Actual observation Deviation7

(y value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

© 2008 Prentice Hall, Inc. 4 – 46
 Values of Dependent Variable
Least Squares Method

Actual observation Deviation7

(y value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

© 2008 Prentice Hall, Inc. 4 – 47
 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

Sxy - nxy Slope

b=
Sx2 - nx2

a = y - bx Intercept

© 2008 Prentice Hall, Inc. 4 – 48

 Excel Functions

Slope - select values of x and y

Intercept – select values of x and

y

© 2008 Prentice Hall, Inc. 4 – 50

 Associative Forecasting
Example
Sales Expenditure
(lakhs), y (thousands), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –
3.5 7 Sales
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Expenditure

© 2008 Prentice Hall, Inc. 4 – 51

 Associative Forecasting
Example
Sales, y Expenditure, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b=
∑x2 - nx2
= 80 - (6)(32) = .25

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

© 2008 Prentice Hall, Inc. 4 – 52

 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(expenditure)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –
Sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $3,250,000 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
© 2008 Prentice Hall, Inc. 4 – 53
 From the following data obtain the regression
equation for Spicejet Airlines

Sales : 6 2 10 4 8
Ad expenditure : 9 11 5 8 7

Identify dependent and independent variable.

If advertising expenditure is 15 lakh , how

much would be the sales?

What is the benefit of this expenditure on the

sales of the tickets.

© 2008 Prentice Hall, Inc. 4 – 54

 Zaara sets different prices for particular ladies
garments in eight different regions of the country.
The below table shows the number of unit sold
and corresponding prices ( in hundreds of dollars)
Sales : 420 380 350 400 440 380
450 420
Price : 5.5 6.0 6.5 6.0 5.0 6.5
4.5 5.0

1) Is there any association between price and

sales.
2) Identify the sales if price is 8.9 ( in hundreds of
dollars)
3) What are your findings from the above trend and
relationship.
4) What are recommendations to the company.
© 2008 Prentice Hall, Inc. 4 – 55